I know it has been quite a while since my last post. Tax day has come and gone, and here we are the Spring holiday season. As we enter a time of rebirth and new beginnings, it seemed an appropriate time to return to the blog.
On to my second post on the topic of how we determine your family’s contribution. The first post was on parent contribution from income. This post will be in regard to the parental contribution from assets.
There are some assets that are included in both the IM (Institutional Methodology – used by schools to award their own money) and the FM (Federal Methodology – used to award Federal funds) formulas. These include:
- Cash and savings accounts.
- Stocks, bonds, mutual funds, and other regular (i.e. non-retirement) investment accounts (including life insurance cash value).
- Real estate other than your primary residence (including investment real estate, 2nd homes, etc).
- Businesses or farm equity (this amount is not at a 100% assessment rate, you report the total amount on the form and we make an adjustment based on a table, usually somewhere between 40% and 50% depending on the amount of equity). Special note: Businesses not owned by your family OR that have more than 100 employees are included; others are ignored. In order to determine what makes up your business or farm equity, some colleges may require a business or farm supplement for each business you own (this may include a Schedule C, Schedule F, Partnerships, S-Corporations, and regular Corporations tax returns).
Some assets are ignored from both formulas. These include specially designated retirement accounts like 401K accounts, IRAs, KEOGH plans, etc (although remember the amount of the current year’s contribution was added back as non-taxable income before).
One particular asset is included only in the IM formula, and not in the FM formula. This is the home, or the primary residence. Some colleges may use a number of modifications to your reported information to arrive at a reasonable value while other may use your entire home equity as an available asset, so you may want to confirm with the institution what policy they have in place.
Why is the home not included in FM? In 1993-94, the Federal Government removed the home from the financial aid formula. This was done for several reasons, I believe, none of which make particular sense from the point of view of assessing a family’s ability to pay for college. The action of removing this asset from the formula was to, in effect, pretend there is no difference in a family’s financial strength whether they rent an apartment or own their home. Private colleges determined that this analysis wouldn’t work for them, so they created their own process to analyze financial aid (therefore the birth of the Institutional Methodology). There are very many other differences between IM and FM, but the issue of home equity serves as the starting point for their divergent paths. A history book on this subject is just itching to be written…
So enough history, what does colleges actually do?
Some start by looking at what year you purchased your residence and how much the purchase price was in the year in which you purchased it (I say you when in fact, more than probably, it is your parents’ house). Based on a table which eliminates regional variation, they may determine how much the property should be worth today. This table uses a national coefficient so that parents are neither penalized or advantaged by living in an area where values over time have deviated from the national norm. The chart is is not publicly available. The underlying information comes from here though.
Once the college determines the value as shown by the multiplier, they may compare that to your stated value (on the Profile application) and in some cases they will use the multiplier value (or they may use your stated value on a case-by-case basis, usually if it is lower than the multiplier value).
The next item some colleges examine is whether you could access the value in your home. To determine this they cap the total value based on your total income. Let’s say the cap is 240%. So, a family who earns $100,000 a year would have their home value capped at $240,000. In other words, a collge using a 240% cap would cap your home value at 2.40 times your income. This is to protect families who, due to real estate market growth, live in a home that they could not afford to purchase today. The college caps the value of the home at this amount to account for the fact that a family could not afford to qualify for a mortgage to access equity higher than this level.
The college then takes the lower of these two numbers into account as your total home value, and then subtracts debt from that to determine the home equity. Again keep in mind all of this is an example of what a college may do to award their own money. Colleges must use FM (which does not include home value) for Federal funds.
Another asset some colleges consider under IM is the student’s siblings’ assets since they try to get a whole picture of a family’s net worth (they will also later provide an allowance against these assets for the siblings’ savings for college). In addition, under IM, colleges may consider all student assets (with the exception of trusts) to be family assets as well so that students will not be penalized for saving for college (due to the higher rate used in the student-only analysis).
Once all of your assets are in place, the college then subtracts allowances from them to determine your net worth. The allowances are different depending on the formula.
The following allowances are subtracted under the FM formula:
- Education Savings and Asset Protection Allowance — An allowance against assets based on the age of the older parent and marital status. As an example, for a married couple with an older parent aged 48, the amount is $21,300. For a one-parent family with a parent aged 48, the amount is $12,900. This amount is supposed to be, according to the Federal formula, a protection against your assets to supplement your retirement and to allow for savings for college for younger siblings of the student.
The following allowances are subtracted under the CA formula:
- Emergency Reserve Allowance — An allowance against assets based on the number in family and in college (modified by a regional COLA – Cost of Living Adjustment – figure) to represent what a family should have saved in case of emergencies.
- Cumulative Education Savings Allowance — An allowance representing how much a family should have saved by this point for college for this student as well as any college-attending or younger siblings. This amount is based on an Annual Education Savings Allowance calculated earlier in the formula.
- Low Income Asset Allowance — If the Available Income calculated before is negative, the amount is subtracted from assets available (to represent that the family is living off of its assets).
The resultant value (Net Worth minus Total Allowances) is then referred to as the Discretionary Net Worth. Discretionary Net Worth is then combined with Available Income and the whole thing is run through a final conversion, leading to somewhere between 22 to 48% of Available Income (based on how high the Available Income is) and somewhere between 3 to 8% of Discretionary Net Worth (again, based on how high the Net Worth is) appearing as part of the final contribution from parents.
This figure is finally adjusted to reflect how many students are attending college in the same academic year. Under the Federal Methodology, the number is simply divided by the number in college (so, if your contribution was $10,000 and you had two in college, each student would have a $5,000 parent contribution).
Under the IM methodology, the resultant number, instead of being evenly divided, is modified by a percentage (60% for two in college, 45% for three in college, 35% for four or more in college); this would mean that for a contribution of $10,000 with two in college, the contribution for each student would be $6,000).
So, I think this is a good general overview of the asset treatment. And here I thought this would be simple. Ask away, since I am sure this will generate questions.
Again, please let me know if this is way too much detail, or not enough information.